Cost to Serve (CTS) – What is it? Why should I use it? How to calculate? What are the main mistakes?

Cost to Serve (CTS) is a methodology that allows you to calculate the total cost of serving a customer, from the moment an order is placed until the moment the product is delivered.

CTS provides insights into profitability at the customer, product and/or channel level. With it, some companies discover that some product lines or customers are less profitable than they appeared to be when analyzed by revenue alone. For example, a high-volume customer may seem valuable, but if the costs to serve them are high due to logistical complexity, their profitability may be low.

Additionally, calculating the cost of serving can help identify operational inefficiencies, such as products with low inventory turnover that are being subsidized by other products with higher turnover or certain sales channels with higher customer service costs. With this information, companies can look for ways to reduce costs, such as optimizing delivery routes or improving inventory management.

In addition, knowledge of CTS can help companies define more efficient and strategic prices, since knowing how much each stage of the order cycle costs to serve different customers or sell different products, it is possible to offer a pricing menu, with a range of of complementary services, such as express freight and segmented stocks to guarantee availability.

The basic steps to calculate the cost to serve are:

(1) Identify all activities that contribute to customer service, such as receiving the order, picking the product, transporting it, customer service, after-sales, among others;

(2) Assign costs to each activity, which may not be trivial as some activities may not have direct costs assigned to them. However, it is important to identify and allocate these costs as best as possible, using a technique such as activity-based costing (ABC) to do this.

(3) Calculate the total cost for each customer, adding the costs of all activities performed;

(4) After calculating the cost of serving each customer, you can identify areas where costs are particularly high and look for ways to optimize those processes.

There are several common mistakes companies make when calculating CTS, such as:

• Excessive simplification in cost allocation criteria, such as equally sharing a certain cost among all products or customers;
• Non-allocation of indirect costs, which need specific drivers and are relevant to the final profitability assessment;
• Absence of cost of capital, since investments in inventory, equipment and other areas of the company have a significant cost, and can be very relevant for new product lines, for example;
• Allocation drivers, which is the factor used to divide costs between different products, activities or departments, inaccurate or inappropriate. If the chosen allocation basis does not reflect how resources are actually used, this can lead to inaccurate cost allocation;

• Ignore changes over time, as a company's operations and the way resources are used can change over time. If the company does not regularly update its cost allocation to reflect these changes, this could result in an inaccurate cost allocation.

It is worth remembering that the cost of serving is not the only factor to be considered when evaluating a customer's profitability. It's also important to consider the total value the customer brings to the company, including revenue and long-term growth potential.

It is also important to note that the cost of serving can vary greatly depending on the industry, the type of product and the type of customer. Therefore, it is essential to have a deep understanding of your company's operations and your customer profile when using this methodology.